Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Value-Based Pricing for Restaurants
Make Pricing Your Ally: How to
Put Value Back on the Menu
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Make Pricing Your Ally:
How to Put Value Back on the Menu
Nothing ruins great food more than bad pricing decisions.
That maxim is particularly true along the ultracompetitive spectrum of
restaurants from quick service (QSR) to family and casual dining. You have
invested heavily in developing your unique brand of food taste and quality,
established an in-store presence attractive to your target segments, and
anchored it with a compelling brand image. That is the visceral, perceptiondriven side of the value equation. But the “money” side of value equation –
driven by pricing – is a challenge more vexing in restaurants than in almost
any other industry.
The money side is murky and messy, but the real concern is that pricing is
preventing restaurants from realizing their full potential. Even in the best
case, pricing seems like a complex nemesis whose easy answers are risky
and whose hard answers require too much time and effort for an uncertain
reward.
It doesn’t have to be that way.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
It’s time for restaurants to make pricing their ally, not their nemesis. The
power and peace of mind that comes from balancing both sides of the value
equation have a huge financial upside in terms of improved profits, without
sacrificing the integrity of the menu and the reputation you have worked so
hard to establish. This is especially true in an industry which typically operates
at net profit margins in the range of 10-15%. Weaving together a great menu
which balances value and price means threading the needle on six challenges
that all restaurants along that spectrum face:
1. Optimizing Guest Count vs. Average Check
The simplest calculation of revenue is average check size and guest count.
The simplest and prevailing logic in the business tells us that higher prices can
reduce traffic, while lower prices and frequent promotions (discounts, value
menus, etc.) can drive higher traffic, especially at a time where overall traffic
in the industry is flat1. But a restaurant which is packed from open to close
may not be generating the amount of revenue it can and should. How do you
find the right balance between ticket size and guest count?
2. Minimum Wage
Margins are sensitive enough in the restaurant business without the
cumulative effects of all the pressures they face. Competitors’ moves and the
allure of higher traffic put downward pressure on prices, while federal, state,
and in some cases local governments are setting higher minimum wages.
How do you reconcile downward price pressure with higher costs?
3. Power of POS data
Restaurants collect a tremendous amount of rich data through their POS
systems.
1. Maze, Jonathan. “Black Box: Same-Store Sales Flat in November.” Restaurant Business, 07 Dec. 2017,
www.restaurantbusinessonline.com/financing/black-box-same-store-sales-flat-november. Accessed 11 May 2018.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
The potential to recognize patterns, make dynamic adjustments to menus,
and predict traffic and ordering patterns is just as tremendous. But until you
find a way to analyze and interpret the data reliably, and turn those analyses
into action, the potential remains just that: potential. How do you leverage
your very rich transaction data without becoming a slave to algorithms or
black boxes, or so myopic that you lose sight of what drives your customers to
your restaurant?
4. The Millennial Revolution
The growing presence and buying power of Millennials has shifted the market
away from standardization. Custom-built items have become the new normal
in the industry. Even chains known for their excellence in standardization
(such as McDonald’s) have introduced “Create-Your-Taste” offers (Picture 1).
Instead of embracing the standardization and consistency which defined their
parents’ and grandparents’ restaurant experiences, Millennials have grown up
accustomed to getting what they want, how they want it, and when they want
it. In light of guests’ desire for more control, how do you balance the
increasing demands for customization with powerful value drivers such as
consistency? How do you price your custom items relative to your standard
ones?
Picture 1: McDonald’s “Create-Your-Taste” kiosk.2
2. McDonalds. McDonald's Create Your Taste Home Page, 2018, www.mcdonalds.com.hk/en/create-your-taste.html. Accessed 11 May 2018.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
5. Rampant Promotions
More players and more categories (e.g. the growth of fast casual) mean
more competitive pressures, which have triggered an almost knee-jerk
reaction from restaurants: discounts, coupons, promotions, just about
anything to keep guests walking in the door. The truth is that overpromoting is like an addiction which undermines your restaurant’s health,
i.e. your brand and your bottom line. Resisting that temptation is a key
success factor in today’s restaurant environment. It boils down to this
question: How do you know when to be proactive and when to be reactive
regarding promotions?
6. Apps, not Appetizers
No business has escaped the overwhelming technological advancements
of the last decade. These advancements create vast new opportunities for
restaurants, such as delivery services, loyalty programs, and mobile
ordering through apps. Mobile apps bring two clear advantages. First, they
extend the reach of your kitchen and brand. No longer must restaurants
rely solely on foot or drive-through traffic, reservation counts, and tables
turned to generate their profits. Second, mobile apps collect a vast amount
of data (e.g. geolocation, delivery fee pricing, ad and offer responsiveness)
well beyond what the restaurant can collect at point of sale. Just look to the
successes of Starbucks (Picture 2) and McDonald’s.
Picture 2: Starbucks app for iPhone 3
3. Starbucks. Starbucks® App for iPhone® and Android™, 2018, www.starbucks.com/coffeehouse/mobile-apps. Accessed 11 May 2018.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
How do you capitalize on those opportunities to create a new relationship
with guests by crafting a superior guest experience and by capitalizing on
the new pricing opportunities these technologies bring?
Determining The Maturity of Pricing
The good news – and the huge opportunity – is that restaurants can put a
pricing strategy and pricing processes in place which offers the guidance, if
not definitive answers, to create and preserve an equilibrium between value
and price. That powerful and valuable equilibrium comes from
understanding where you currently stand relative to each of the six
challenges above, then defining, prioritizing, and executing the steps to
address them. But how do you establish that baseline, decide where to
begin, and determine how to balance expectations between investment
and outcomes? After all, significant price and menu changes are expensive
and risk alienating guests.
It all starts with knowing your current level of pricing process maturity and
determining the realistic and the aspirational levels to aim for. The World
Class Pricing ™ system (see Figure 1) comprises five levels. Where a
restaurant starts and where it ends up in terms of pricing depends on its
maturity level, which we assess using that progression.
Roughly 70% of all restaurant chains fall into either Level 1 or Level 2. This
illustrates the nature of the opportunities for restaurants. Rather than
needing to catch up to peers, they have a chance to carve out a clear
advantage, both commercially and financially, when they make pricing their
ally.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
The levels differ in terms of the intensity of the challenges, their root
causes, and the steps a restaurant needs to take in order to reach the next
level and aspire to progress further.
Figure 1: The World Class Pricing ™ of Pricing Solutions takes a company step-by-step
toward optimization and ultimately to mastery in terms of pricing
Level 1: Lack of Strong Controls
Restaurants at Level 1 show the weakest controls over the discounting
addiction. They rely too heavily on promotions, and they are slow to weed
out the unprofitable stores which contribute to the vicious cycle of
promotions. But the lack of controls extends beyond discounting and
promotional behavior.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Level 1 restaurants use simple rules of thumb instead of grappling with the
six challenges. They make across-the-board price increases (say, 3% on
everything) instead of targeted ones. They suffer from menu proliferation
(“more is better”) instead of focusing on balance. They also use costs as the
basis for their price setting (cost-plus method) rather than using value as the
basis.
The response of one restaurant chain in the face of minimum wage and food
cost increases shows the risks of being at Level 1. The company
implemented a large, across-the-board price increase to offset these costs.
But this price increase bore no relation to the underlying value in its menu.
The result was a lower guest count compounded by lower volumes or tickets
from the guests who did come. The restaurant fell short of its financial goals.
What could the restaurant have done differently?
The solution lies in adopting the practices from Level 2. It starts with
revisiting the core value proposition and reinforcing what the brand truly
stands for. The chain needs to put controls in place that limit the extent and
frequency of promotions and close its unprofitable stores. Finally, the chain
needs to pull back from a “more is better” philosophy and ensure that the
menu closely reflects the core value proposition. In most cases, this leads to
a simpler menu.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Level 2: Controls Are in Place, but Value Is Left
Untapped and Underutilized
Putting controls in place and reaching Level 2 is an important achievement,
but the journey is only beginning. Despite a clearer pricing process and
more controls on promotions, Level 2 restaurants still behave similarly to
Level 1 restaurants in some aspects, albeit to a lesser degree.
One of the key similarities is the continued reliance on simple rules of
thumb. While they manage their promotions better, they still take more of a
“one-size-fits-all” approach rather than targeting specific segments. They
also risk sliding back into the old behavior of heavy promotions if guest
count declines, despite their controls. In the process of identifying and
closing unprofitable stores, they may have developed store tiers, which is
an important step away from using rules of thumb to set chain-wide prices.
But even in that case, they are prone to use costs to define the store tiers,
rather than using value, which is a better metric but which can be harder to
define. Perhaps most critically, they still make price increases based more
on costs than value. Figure 2 illustrates how a restaurant can knock its
price-value relationship out of balance when it uses costs instead of value
as the basis for a price increase.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
The diagonal blue line indicates the threshold where price and perceived
value are in equilibrium. By raising the price significantly above that line, but
keeping the product quality the same, the chain puts its coffee’s price-value
relationship not only at a disadvantage relative to the notional equilibrium,
but more importantly relative to its two primary competitors. The chain used
rising costs as the justification for the price increase, but Figure 2 explains
why making such a move is harmful both financially and in terms of
competitiveness and brand image.
Figure 2: Price value map for coffee, core customer segment. A cost-based price
increase for coffee puts this restaurant, and its core segment, at a value disadvantage
The solution, and the source of future improvement, centers around one
vitally important word: value. One could say that the biggest difference
between restaurant chains at Level 2 and the more value-focused ones at
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Level 3 is that they have the desire, the capabilities, and the commitment to
create analyses like the one in Figure 2, and then interpret them and act on
them. In other words, they start using value – both in the visceral and the
quantitative sense – as their guiding principle for menu and pricing
decisions, rather than costs or short-term competitive pressures. When
they make this shift in focus, they start to segment their customers and
redefine their store tiers based on value. They are also in a position to
redesign their menu around key price points.
Level 3: Add Value-Based Pricing to Your Strong
Controls
The emphasis at Level 3 switches from outright improvement to
enhancement, because restaurants start capitalizing on their firmer grasp
of customer and competitive dynamics. They know their customers very
well by conducting regular research to augment their own POS data. This
helps them gain a deeper understanding of the value drivers in the markets,
and how they perform relative to the competition. Our own research has
found that food quality is the top value driver, ahead of price, regardless of
where the restaurant competes along the industry spectrum from QSR to
casual.
This extensive knowledge base, combined with an understanding of value
vs. cost, enables restaurants to make pricing decisions which are more
tightly aligned to their core value proposition.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Restaurants at Level 3 undertake smart redesigns of their menu, building
around key customer segments and key price points, such as breakfast
deals at $5 and lunch deals at $10. These prices do not come from thin air.
In our price expectations research, we use “fair price/think twice” questions
to uncover customers’ price thresholds. This research has repeatedly
shown that $10 is a key price threshold for lunch. In the spirit of the control
and discipline they fostered at Level 2, many chains at Level 3 reinforce
these key menu price points but by offering discounts only to key segments
of the market.
Figure 3: Example of “Fair Price / Think Twice” analysis for breakfast
A more comprehensive, value-based pricing approach also extends to the
determination of store tiers. Instead of treating all stores the same, or
focusing on a few simple metrics, the restaurant group takes all 4 C’s
(customer, costs, competition, and conditions) into account in order to
maximize value across the group. When we analyze individual restaurants
across an entire system, we generally find less price sensitivity in areas
where there are many travelers (customers), few nearby competitors
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
(competition), high wages (costs), and high household income (conditions).
This combination creates a set of pricing opportunities not present at stores
where, for example, competition is much more intense and local
purchasing power is lower.
The more rigorous and quantitative the store-tiering analysis is along the 4
C’s, the greater the chances the restaurant can isolate and seize specific
pricing opportunities. An analysis we performed for a restaurant chain with
over 900 stores revealed that most locations with no key competitors
located within 1,000 feet could increase prices without losing volume. The
extent of the changes varied from store to store based on the other C’s, but
this one change alone was responsible for over $5 million in additional
revenue. What made this incremental revenue possible was the underlying
analysis involving thousands of data points and millions of
interrelationships.
One risk that restaurants at Level 3 face comes as they make the transition
to value-based pricing. The intensive focus on this new pricing approach
cannot come at the expense of the discipline and controls the company has
implemented to improve its revenue and profit situation in the first place.
Value-based pricing should in fact build upon this discipline and control.
Level 4: Optimize Your Value-Based Prices
Restaurants at Level 4 have implemented value-based pricing, but their
journey is far from over. Thanks to market dynamics as well as ongoing
improvements in capabilities, technology, and data, these chains now face
the challenge of optimizing their menu prices.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Optimization not only preserves the gains from previous levels, but also
yields additional incremental profit improvement.
Menu optimization is an iterative, ongoing process which requires a
considerable amount of data and analysis. The process starts with
identifying price elasticities at the category level, or ideally at the item level.
By knowing how sensitive the volume of each menu item is to changes in
price (both small and large), the restaurant can develop a predictive model
which shows how revenue, guest count, profits, and other key metrics
move as prices change. Just as important are the interrelationships
between menu items and price changes, i.e. the substitution effects and
the basket effects. The model, in turn, allows the chain to make decisions
on optimal prices for each menu item and bundle.
Getting accurate estimates of price elasticities allows restaurants to identify
the extent of their pricing latitude across the menu. The analyses reveal
areas where the restaurant can raise prices comfortably, where changing
prices would be risky, and even where lower prices would be
advantageous. Generally speaking, there are many menu items that are
price-inelastic, meaning an increase in prices results in only small decline in
volume. Higher prices are therefore worth considering. Conversely, some
products are consistently price elastic. For example, beverages –
regardless of whether they are soft drinks or alcohol, hot or cold – are more
sensitive to price changes than food items are. In fact, they are sensitive
not only to changes in their own price, but also changes to food items’
prices.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
One restaurant learned that latter point the hard way with its breakfast
menu. Its aggressive price increases on breakfast sandwiches inadvertently
its coffee sales, as guests continued to buy the sandwiches but stopped
buying coffee in order to keep their total ticket constant.
Three kinds of analyses provide the necessary insights for menu
optimization.
Leveraging POS (and App) Data
POS data – supplemented by App data if available – is a unique, renewable
resource. It is continually refreshed and increased with each guest
purchase, it is visible only to the system which collects it, and it incurs no
third-party acquisition costs. Once again, the analyses based on this data
must capture both the direct and indirect effects of potential price changes.
Calculating the direct price elasticity, i.e. the impact of an item’s price
change on its own volume, is the easier part. More difficult, but just as
essential, is the measurement of the substitution and the basket effects.
The substitution effect occurs when a price increase on one item prompts
guests to shift their consumption to other menu items they perceive as
better value for money. The basket effect occurs when a price change in
one item affects the volume of a complementary item (such as sides or
beverages).
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Figure 4: Measuring the total impact of a price increase on the business by analyzing
direct, substitution and indirect effects.
Testing (In Store)
This method is well suited for getting direct feedback from guests while
minimizing the financial and commercial risks. By limiting the test to a small
number of locations and/or items, and by keeping the test period short, the
restaurant gains valuable insights into how guests will respond to menu
and price changes, but without exposing the entire system’s guests (and
its competitors) to the changes under consideration. These tests generally
run for 1-2 months in order to give guests multiple interactions with the
changes. One chain (see Figure 2) ultimately used this approach to
redesign its high-priced coffee offer, a move which drove millions of dollars
in revenue and profit improvement. The method is widely used to test the
effects and performance of new products. But we feel the method is
underutilized as a means to test price changes, in part because of
restaurants’ reluctance to test prices in market.
Testing (Online Surveys)
This approach is especially appealing when the changes under
consideration are too bold or risky for an in-store test.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
The best practice for these surveys is Menu-Based Conjoint (MBC). This
method allows pricing departments to conduct controlled randomized
experiments with prices and collect valuable data from the respondents.
This method also has an advantage which both POS data and in-store
testing lack: the ability to capture non-customers as well as a sufficient
numbers of light users, who may be inclined to visit more and consume
more if the price-value relationship or menu composition changed. Surveys
offer a means to gather information from both of those groups and also
understand the reasons behind their current behavior.
MBC is not only a powerful analytical method, but a confidence builder as
well. When a QSR chain wanted to redesign its value menu and push some
low-price items beyond the critical thresholds of $1 and $2, we conducted
an MBC which helped them gain the confidence and knowledge needed to
successfully implement the changes such that they improved business
performance.
Level 5: Pricing Mastery over Time
Level 5 companies have typically honed their skills at Level 4, have superior
profitability to their industry peers and the CEO sees pricing as a source of
competitive advantage. Their pricing processes are optimized machines
which are “well oiled” with a constant inflow of valuable data. Level 5
companies have completely integrated pricing into their business. The
pricing function, often led formally by a Chief Pricing Officer, reporting into
the C-Suite. Given the dynamic nature of the restaurant industry there are
very few companies that can claim to be Level 5.
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Pricing Solutions. Make Pricing Your Ally: How to Put Value Back on the Menu.
Conclusion
When we build a high impact pricing strategy for a restaurant business, the
goal is to optimize overall long-term profitability. As a restaurant makes the
upward progression from Level to Level, it becomes better and more
confident in addressing the six challenges which make pricing in the
restaurant industry so difficult. It also abandons one-size-fits-all thinking,
simple rules of thumb, and reactive tactics, in favor of a data-driven
approach which provides insights at the individual store, menu item, and in
some cases even guest level. The right pricing strategy, backed with the
right model, increases overall returns by improving the complex interplay
between guest count, menu design, and ticket size.
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About Pricing Solutions
At Pricing Solutions, it is our mission to dramatically
improve client’s profitability and market share
through improved pricing. We have grown to
become one of the world’s leading pricing
consultancies with offices in North America, Europe,
the United Kingdom, Asia Pacific and Latin America.
We focus on all of pricing, and only pricing!
Pricing Solutions specializes in four
core services:
Pricing Strategy
Pricing Analytics
Pricing Research
Pricing Training
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All Rights Reserved.
www.pricingsolutions.com